State Supreme Court Ruling Coming Soon on Risk Transfers to Subs

January 14, 2014

An important ruling in Transtar Electric, Inc. v. A.E.M. Electric Services Corp. on the issue of general contractors (GCs) using "pay-if-paid" clauses to sidestep lien rights and avoid paying subcontractors is expected to be handed down by the Supreme Court of Ohio by spring, sources in the state told NACM this week. Such a case is important to watch because, as NACM Secured Transaction Services' Chris Ring characterized it, such clauses are "a kissing cousin to a no lien contract" and an infringement on subcontractors' rights.

On November 5, the state high court heard arguments in the case, in which Transtar wasn't paid for work provided on a swimming pool project at a Holiday Inn because the GC tried to invoke pay-if-paid language to avoid payment when the property owner faced insolvency. Though a trial court originally found in favor of A.E.M., an Ohio court of appeals saw the language as unfavorable and hinted that such a clause was unfair in its essence, reversing the decision. The December 2012 appeals decision noted "we find no language sufficient to clearly and unambiguously indicate that the parties intended to transfer the ultimate risk of nonpayment to the subcontractor." The decision also included criticism of pay-if-paid clauses for being generally "disfavored" as well as being banned or limited in a number of states. A state Supreme Court reversal to A.E.M.'s favor would potentially harm subs working in Ohio, not to mention serve as something that GCs from other states could try to use to support pay-if-paid attempts in their own areas. Supreme Court decisions in Ohio are usually released about five months after oral arguments are heard.

"A pay-if-paid contract does not strip away lien rights. However, it limits the ability of a payee to pursue legal action and obtain a judgment against the payer in the event of nonpayment," Ring said. Regardless of the outcome, it spotlights the need for credit managers to insist on reviewing large-dollar contracts before they are signed. "A credit manager that has the chance to assess the risk associated with the contract can give the sales rep options so they can try to negotiate things like pay-if-paid clauses out of the contract," Ring suggested. In this case, since Transtar's work in 2007, there have been no payments made and the case has been tied up in courts. If clauses similar to pay-if-paid were removed back then, this issue might have been long resolved.